The Insolvency of the Fed

February 6th, 2009

Back on July 24, 2008, I penned a post titled The Sad History of Paper Money, in which I noted that money not redeemable in either gold or silver is printed until it is worthless. Now mises.org has posted an article titled The Insolvency of the Fed that starts Since August 15, 1971 the US dollar has been an irredeemable paper currency. Every irredeemable paper currency in history has failed. The people at mises.org know as much about money (the history of money, what money is and what it should be) as anyone around, and their writings are important looks at today’s monetary situation.

The article is an excellent educational piece for investors trying to get better understandings of just what the Fed (and the fedgov) is attempting to achieve in the bailout of the banking industry. More important, the article explains why the Fed is headed toward insolvency, something that the average person thinks is impossible.

The article also provides insight into the workings of the Fed. As you might guess, the authors are not fans of the Fed, and they lead readers to understand why they titled the piece The Insolvency of the Fed.

The article notes that because of the banking crisis the Fed now holds lower quality assets. (There was a time when the Fed was restricted to buying only U.S. treasuries.) Not wanting to increase its balance sheet (increase its total assets), the Fed started the bank industry bailout by trading U.S. treasuries for bad assets held by troubled banks. The banks got the good assets; the Fed got the failed (or failing) assets.

With Fed valuing both assets the same, the Fed’s balance sheet was unchanged. But, as the crises worsened, the Fed had to “increase its holdings,” which means that it began printing money to buy bad assets from the banks. And, things look to get worse.

But what new assets is the Fed acquiring? The Fed has already started buying the debts of Fannie Mae, Freddie Mae, and the Federal Home Loan Banks. It has also bought mortgage-backed securities issued by Fannie Mae, Ginnie Mae, and Freddie Mac. Bernanke is also considering buying other securities backed by consumer loans, credit card loans, or student loans.

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